Is Buffett betting on Medicare and Medicaid?

MeenaKrishnamsetty

Ms. Krishnamsetty is editor and co-founder of
Insider Monkey, a finance website
that provides free insider trading and hedge-fund stock-holdings data. Her
articles draw upon the research and analytics of co-founder Dr. Ian Dogan,
Insider Monkey's research director, who holds a Ph.D. in financial economics
with a specialization in insider trading. Dogan has provided consulting services
to institutional investors and hedge funds, and managed a $200+ million fund
using a strategy he developed tracking
insider transactions.
Dogan authored the insider trading chapter of the soon-to- be-published “The
Handbook of Investment Anomalies” by Zacks Investment Research. Prior to Insider
Monkey, Krishnamsetty worked for Bloomberg Television, CNBC, NPR and in risk
management at Marsh & McLennan. Krishnamsetty has an M.S. in Journalism from
Columbia University’s Graduate School of Journalism.

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One of the strategies we use is to track billionaire and hedge fund purchases and then mimic them, if they seem in line with our investment philosophy. In this case, we’ll be looking at the Warren Buffett and an interesting purchase he has made in the health care space.

The Oracle of Omaha's Berkshire Hathaway continues to buy up shares in DaVita HealthCare Partners
DVA, -1.08%
with the company’s 13F reporting that it held 10.2 million shares at the end of the third quarter — a 10% increase from three months earlier — and after the most recent buys, it now owns over 13.6 million shares. At the current price that would give Buffett about $1.5 billion invested in the company, making it one of his 10 largest holdings by market value (see Buffett's top stock picks). DaVita specializes in kidney dialysis treatments, including medical centers and lab services, and has a market capitalization of just over $10 billion.

About half of DaVita's dialysis-related revenue is paid by Medicare, meaning that the company is very sensitive to changes in the program including those which may come as a result of President Obama's new health-care plan. Another 16% is paid by Medicaid and Medicaid-related programs.

Aside from Procter & Gamble (which Buffett has been selling), DaVita HealthCare Partners Inc appears to be the largest health-care-related stock in Berkshire's portfolio (and P&G would be better characterized as a "personal products" company which has little to no exposure to public policy). DaVita currently trades at 19 times trailing earnings; its revenue and earnings have been up moderately recently, but there's little telling how relevant that will be to the company's future performance. Wall Street analysts see growth continuing at least for the next year, and the forward P/E is 15.

There has been a ring of insider sales at DaVita by company officers and Board members beginning in early November (see a history of insider sales at the company). However, we'd note that most of these sales came at prices above $110, slightly higher than the current share price. In addition, insider sales often are rational as they allow insiders to diversify their wealth away from the same company (and economic trends) that are responsible for a large portion of their income, and we think this particularly makes sense for insiders at health-care companies. Still, investors should be aware of the sales.

Billionaire Stephen Mandel's Lone Pine Capital owned just over three million shares of DaVita HealthCare Partners Inc at the end of the third quarter (check out Mandel's stock picks). Mandel is a Tiger Cub, having previously worked at Julian Robertson's Tiger Management. Another successful Tiger Cub, Andreas Halvorsen, currently heads Viking Global; Viking was another major shareholder in DaVita, reporting a position of 2.9 million shares of the stock (find Halvorsen's favorite stocks).

Acadia is the growth story of the lot: its net income more than doubled between the 2011 third and quarter and last quarter, though trailing profits are fairly low. Continued growth is expected to bring its 2013 earnings high enough for a forward P/E multiple of 23, though there is significant short interest in the stock.

Mednax and Healthsouth have been seeing good revenue growth, though Healthsouth's earnings have been slipping. Each of these companies trades at a discount to DaVita: their trailing P/E multiples, for example, are 17 and 12. Of course, all of these peers are in distinct businesses, but all of them should be affected by any changes to Medicare or Medicaid.

DaVita doesn't look particularly attractive compared to these other companies (though, of course, it would be difficult for Buffett to build up a large position in these smaller peers; as it is Berkshire owns a substantial amount of DaVita's outstanding shares). It therefore seems that Buffett and his investment team aren't worried at all about budget cuts, and in fact see health-care provision as an undervalued industry (or it's possible that they are bullish on kidney treatments in particular). We would be more cautious, both relative to the company and the industry, but it could be useful to take note of Berkshire's continued purchases of the stock.

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